Copper has spoken. Its voice is the loudest of the commodities, and it’s not optimistic for the global economy.
The coronavirus–which had by the time of writing claimed 490 lives and infected over 24,300 people–is battering all commodities right now, but it’s copper that the oil bulls should be watching because this is the barometer of global economic health, which speaks volumes about future oil and gas demand.
Flights to China have been cancelled, and Chinese manufacturing plants have been closed down, with rumor of force majeure in the works for commodity supply contracts.
By Monday, copper had seen a 12% drop in price.
Economists in Beijing think Q1 growth rates could drop a percentage point or more.
That’s bad news for copper above all, and what’s bad for copper is bad for oil and gas.
What Does Copper Have To Do With Oil?
Because it’s tied so closely to manufacturing, industrial production, construction, engineering, and–most recently–information technology, not to mention a host of other sectors, copper is pretty much the best indicator of global economic strength and global demand.
There is a clear correlation with the price of oil because both commodities are affected by the same fundamental economic factors. And that’s not even considering the energy costs related to copper mining and refining itself.
It’s not a 1:1 correlation, though, and it’s changed quite a bit over the past decade and a half, and particularly since the U.S. shale boom and gains made in the renewable energy sector.
But the fact remains, the connection is incredibly strong, and sustaining:
Where the two could eventually diverge is where energy itself diverges into fossil fuels and renewables–the new “paradigm” that could upset the long-running correlation between copper prices and oil prices, according to Lobo Tiggre, writing for Kitco.
The Commodities Bloodbath
As the world’s largest buyer of copper, a virus panic that has led the Chinese State Grid to put all new tenders on hold, as well as call off oil imports, has shaved a big chunk off the price of most major commodities.
But one point where copper and oil don’t directly track is with relation to sulphuric acid, a byproduct of copper production mostly used in fertilizers, which has also seen demand evaporate amid factory closures in China. Sulphuric acid prices have shed more than half their value in a month, and Hubei, where the virus originated, accounted for 20% of China’s sulphuric acid consumption.
Analysts suggest that the coronavirus has so far led to a 20% reduction in oil demand coming out of China, with refineries cutting back output or shutting down altogether.
According to Fortune, China is even attempting to sell millions of barrels of West African crude it had already purchased. The magazine also cited BP CFO Brian Gilvary as predicting that the coronavirus could reduce growth in global consumption by one-third.
The Million-Dollar Question
The million-dollar question is, of course: How fast can Chinese manufacturing recover?
It’s an unanswerable question in the face of a virus that continues to accelerate its pace of infection globally.
There can be no real talk of a recovery until we’ve hit peak infection for the coronavirus, and right now, no one can agree on how big of a drop in consumption is in store.
While Bloomberg is saying that crude oil has lost 20% of daily demand from China, Wood Mackenzie thinks it’s more in the neighborhood of 3.5%.
So, can we watch copper for indications of what will happen to crude oil demand?
Yes, but not 100%–and not when it comes to the exact timing of a recovery.
For one thing, as the Wall Street Journal points out, indications were before the coronavirus outbreak that Chinese oil-supply growth was already surpassing fundamental demand at the end of 2019. If that scenario proves to be true (and we don’t have all the necessary data to determine this), then there could be extra inventory for some months to come.
For copper, in which China counts for over half the global demand, the recovery could be faster, but the question is: Recovery to what?
The coronavirus isn’t the only bogeyman scaring commodities; the trade war has also taken its toll.
Even though copper prices were given a bit of a reprieve on Wednesday when investors responded positively to the Chinese central bank’s move to pump stimulus into the economy, it may not be enough to offset the damage.
Reuters cited Xiao Fu, head of commodity market strategy at Bank of China International in London, as saying on Wednesday that he didn’t think the rally would be “sustained”, and cautioned about Chinese economic data scheduled for release later this month that could negatively affect sentiment. “The stimulus can be effective to a certain extent, but the operating rates of some manufacturers and ports will face some physical constraints, so that would be reflected in the data later on,” he said.
For now, stimulus or not, it’s not looking good for copper with Chinese smelters reducing output by over 15% this month (month-on-month) as a direct result of the virus outbreak.
But both copper and oil gained Wednesday on various headlines, including Chinese stimulus, a potential coronavirus drug, and a general sentiment that the virus may be reaching its peak.
In the meantime, it’s worth noting that the market is perhaps right to respond as negatively as it has been over the coronavirus. This is not 2003 when we witnessed the SARS outbreak. Today’s China is a much larger beast and its global reach is that much greater. In the era of ever-expansive globalization, it’s not just copper and oil that are tracking each other–it’s everything tied to everything. While the market didn’t even blink when SARS shaved 1% off China’s growth rate, this time around, even half a percent would be “seismic”, CNBC quoted Taimur Baig, chief economist and managing director for group research at Singaporean bank DBS, as saying.